Taper tantrum - Economics Weekly

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Taper tantrum - Economics Weekly

Rarely has doing nothing prompted such a big market reaction. Investors had convinced themselves that the US Federal Reserve would have started "tapering" its quantitative easing purchases last week.

Economic Analysis

23 September 2013


Fed surprise

The US Federal Reserve was widely expected to slow its quantitative easing (QE) purchases last week, but surprised the markets when it maintained its bond-buying at $85bn a month. Expectations had seen interest rates across the economy rise more than 1 percentage point since May, leaving households paying more for their mortgages and higher financing costs for businesses too.

The Fed, worried that this tightening in financial conditions could dampen the economic recovery and the labour market, thus refrained from reducing its stimulus programme. The reaction from the markets was instant, with the dollar slipping 1% and government bond yields around the world falling.

A long path back to higher US interest rates

In addition to the US Fed's QE announcement, committee members published their estimates for growth, employment and interest rates to 2016. For the last year of the forecast, the central bankers think growth will be above its long term rate and that unemployment will have fallen to 5-6%. In other words, the economy will be performing strongly. Yet despite that strength, many on the committee expect interest rates to be 2% or less - rates previously consistent with recessions. The path back to normal monetary policy conditions will be long.

Is there a UK house price boom? Probably not, although there is a range of estimates. For July, the ONS says average prices grew 3.3%y/y. This is considerably lower than the Halifax number of 5.7%y/y. Nationwide says 3.9%y/y while the Land Registry tells us that for England and Wales prices only grew 0.8%y/y.

What they have in common is London house prices growing considerably faster than the UK average. This complicates the picture for the Financial Policy Committee should it decide to intervene in the market - how to calibrate policy to one part of the UK, whilst not overly harming others.

Catch 22

The minutes of September’s Monetary Policy Committee (MPC) meeting acknowledged growing upside risks to growth and that the MPC’s unemployment forecast is sensitive to "relatively small changes in assumptions". The implication: unemployment might fall below 7% earlier than expected. While the MPC reiterated that 7% is not a trigger for rate rises, they are in a bit of a Catch 22. They want borrowers to believe that interest rates will remain low to support the recovery. But if borrowers believe this, and expectations of growth improve, then rate hikes will start to look more imminent.

Retail sales disappoint in August

Excluding auto fuels, retail sales fell 1.0% on the month - the first m/m fall since April and the biggest fall in more than a year. It seems July's burst of indulgence, which saw the strongest food sales in two years, left us feeling a little guilty.

Food sales were the largest contributor to the decline. This is the first sign that the recent flurry of economic activity may have been getting a little ahead of what the economy is currently capable of. After all, though CPI inflation fell slightly in August, to 2.7%y/y from 2.8% in July, it is still well above average wage growth.

Some respite for the public finances

The government deficit was £13.2bn in August, lower than the £14.4bn shortfall recorded in August last year. While the books remain far from balanced, stronger growth has supported a marked rise in tax receipts. This helped reduce government borrowing by £3.6bn over the first five months of the fiscal year. While these data are volatile and subject to revision, it is pleasant to see growth providing some help to the beleaguered public finances.

Ireland grows again

Ireland came out of recession in Q2, helped by exports and consumer spending. Good news for the Celtic nation, though the 0.4%q/q growth was much weaker than expected. Ireland will continue to benefit from loose monetary policy across the euro area. Eurozone inflation fell to 1.3% in August, from 1.6% in July, and is expected remain below the European Central Bank’s (ECB) 2% target through 2014. This should give the ECB plenty of scope to keep interest rates "at present or lower levels for an extended period of time", as stated by President Draghi.


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The classification of this document is PUBLIC. © Copyright 2013 The Royal Bank of Scotland plc. All rights reserved.


This would have been the first move towards tightening monetary policy. The Fed surprised markets by standing pat. This sent government bond yields lower and stock markets higher. Forward guidance was supposed to increase transparency and reduce uncertainty about the Fed’s thinking but that’s tough when the number of factors affecting decisions is large and when market participants hear something different from what the central bank says. Markets may now have a little less confidence in future Fed communications.

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